Friday, April 02, 2010

Keep Your Government Hands Off Social Security

-- Posted by Neil H. Buchanan

My FindLaw column this week (here) extends my critique of the recent front-page article in The New York Times that claimed to show that Social Security has reached a "tipping point" and is now in much worse shape than we thought it was. Those who read my Dorf on Law post last Friday (here) will find the first half of the FindLaw column very familiar, as I again try to explain the fundamental errors that the article's author commits. The second half of the column discusses a more fundamental question about Social Security's finances, i.e., whether the decades of annual surpluses (memorialized in the Trust Funds) were truly "saved." I show that they were, in the only meaningful sense in which it is possible for an entire economy to "save" for the future.

The broader point that I make in the column is that the "intergenerational deal" represented by Social Security is under attack by people who want to bring the system down. Their best strategy is to convince one party to the deal (post-Boomers) that the other parties to the deal (Boomers and the Greatest Generation) are ripping them off. Because macroeconomics is complicated and often counter-intuitive, it is all too easy to confuse people with half-truths and double-talk, making it seem as though things that have very real effects are not "real" because they are tracked through accounting conventions. Money is ultimately a fiction, so everything that is tracked in monetary terms can be twisted into seeming fictional, too.

Here, however, I want to turn to a different point regarding Social Security's future. The facts are not in dispute: Even though the Social Security Trustees use very, very conservative economic assumptions (even for their "rosy scenario"), their forecasts show that leaving the system alone will allow full scheduled benefits to be paid for two or three decades or forever (depending on how pessimistic one wants to be). If cuts do become necessary, scheduled benefits would have to be reduced by 25-35% as the system returns to annual pay-as-you-go financing. That 25-35% cut, however, is not as big as it seems, because the scheduled benefits in two or three decades are (in inflation-adjusted terms) going to be much higher than today's benefits. Even if the cuts become necessary, therefore, the real standard of living of future retirees will not be lower than today's.

Just because there is no programmatic reason to change Social Security, however, does not mean that there might not be other reasons to do so. The most obvious reason to consider changes in Social Security is that medical costs might continue to rise so quickly that it will be necessary to find savings in other parts of the budget to offset Medicare and Medicaid expenditures. As I have pointed out many times, even the biggest deficit hawks admit that Social Security and all non-entitlement spending are not a serious long-term problem. It is all about medical spending. If the current trends are not reversed, the budget really will be busted. The recent health care bill is surely going to help, but we do not know if it will be enough.

Therefore, we might consider cutting Social Security benefits or raising FICA taxes in order to reduce annual overall federal deficits going forward. I have argued (here, pp. 282-86) that this is a bad idea, essentially because it would enable the health care system to continue to gobble up the rest of the economy. I continue to believe that this is true. Indeed, I am more convinced than ever that the only way to combat health care inflation is to force the political system to confront it directly.

If I am wrong about that dynamic, however, there are surely some simple, relatively progressive changes to Social Security that could be adopted. Lifting the cap (currently $106,800) on labor income subject to the FICA tax would turn the tax from a regressive-by-design tax above the cutoff level to a flat-rate tax, which would be a distributional improvement. Similarly, expanding the Social Security tax base to include capital income could raise significant sums of money in a progressive fashion. Changes in benefits could also be designed in unobjectionable ways, for example, removing some built-in incentives to retire before a person might otherwise choose. Any combination of such changes could raise large sums of money into the indefinite future, reducing overall government debt and -- if done correctly -- insulating Social Security from claims of being on the verge of bankruptcy.

As plausible as that might seem, however, I believe that Social Security should remain strictly off limits. The simple reason is that I do not trust Obama and the Democrats. Tuesday 's announcement that Obama wants to drill, baby, drill, is only the most recent example of how this administration operates. Even the health care bill, though ultimately a political "win," was an awful bill in many ways. It was acceptable, in the end, only because the underlying health care system is such a mess. Since Social Security continues to be an extremely well-run system (with, for example, administrative costs that are only a fraction of those of private systems), there is no reason to open it up to tinkering.

It is, after all, far too easy to imagine Obama capitulating to all kinds of demands from Social Security's opponents. Less progressivity in the structure of benefits? "I'm reluctant, but this is necessary to try to reach an agreement." Real cuts in benefits (through, say, game playing with inflation adjustments)? "Gee, I guess we have to, to be bipartisan." Maybe even a carve-out for private accounts (Bush's dream)? "Well, I hope it's not necessary, but I am open to all ideas." And then, of course, there would be a flurry of business tax breaks added on, to prove that Obama is not "against small business."

In other words, just because there are unobjectionable ways to change Social Security does not mean that today's politicians will stay within those bounds. When it was in their political interest to do so, the Democrats -- even though they were in the minority in both houses of Congress -- killed Bush's attempt to begin to privatize Social Security. Unfortunately, the dynamics of the Democratic Party, particularly in the era of Obama, perversely all but guarantee that if they take the lead in "fixing" Social Security, they will end up undermining it, or worse. This is not a door that should be opened.

7 comments:

1. By investing the SS surplus in treasuries, the government lessens what it has to borrow from the public for the general deficit -- i.e., the surplus in effect "finances" private growth, because there would otherwise be a "crowding out" of private investment (more borrowing without the surplus offset).

Next question:

2. Would it not be a smarter use of those treasury inflows (when the government borrows from SS) to pump them directly into SS in some way, or pay down debt, rather than spend them for general purposes? I think part of your answer might be: well, we could do that, but that would just push more of the general debt onto the public.

Sorry for my convoluted questions. Just trying to clear up my headache. :)

As an aside, one of the more ridiculous things I hear is that SS "IOU's" are worthless. That can only be true if one thinks the safest investment in the world (U.S. treasuries) is worthless.

I agree whole-heartedly with the title of your post. Keep your government hands off Social Security. After all, without government hands, Social Security couldn't be mandatory. Then I could opt out of it and invest that money in something meaningful.

(1) Yes, exactly. If the government would have borrowed $3 but for a $1 Social Security surplus, and it only has to borrow $2 because of that surplus, then $1 of crowding out was avoided. That is the same thing as saying that $1 of productive private capital came into existence that wouldn't have come into existence without the SS surplus. That's saving.

(2) The only way to "pump [the annual surpluses] directly into SS" is to do exactly what we did. We used the annual surpluses to reduce overall government borrowing, and we kept track of the surpluses plus interest. The SS system is legally entitled to spend that amount on future benefits.

We did, in fact, use the surpluses to "pay down debt" by reducing the amount of debt that we otherwise would have incurred. There is less public debt now than there would have been without annual SS surpluses.

Another way to think about it is to say that we use the Trust Funds to keep track of how much the SS system over-collected and thus made available to the general Treasury. That simply keeps things straight in terms of whether it will be necessary for a future Congress to act to fully fund future benefits or cut them.

Even though the Trust Funds matter for internal accounting, however, they mean nothing in the aggregate. That's why the half-truths are so easy to fling in this debate. In one way, it's true that there is "nothing" in the Trust Funds, because they simply represent a pre-commitment by the government to pay full scheduled benefits at least until the Trust Funds (including credited interest payments) have been used up.

There is, therefore, no vault in which SS funds reside. Of course, there's no vault in which my 403(b) resides, nor my savings account, nor my mutual funds. Those, too, are accounting conventions that merely show how much money someone is promising to pay me at a future time under certain conditions. They could all go bankrupt, and I'd be out of luck. SS will not go bankrupt, because it is backed by the full faith and credit of the federal government. Financial players treat Treasury securities as risk-free, for a good reason.

Lots of people who thought that their retirements would be more comfortable because they had invested in meaningful private securities found out that those promises were meaningless. SS recipients, on the other hand, are still receiving their scheduled benefits.

Of course, there's no vault in which my 403(b) resides, nor my savings account, nor my mutual funds. Those, too, are accounting conventions that merely show how much money someone is promising to pay me at a future time under certain conditions.

I strongly disagree with this statement, at least in the case of mutual funds. Your statements show you how much your investments are worth today, on the open market.

Lots of people who thought that their retirements would be more comfortable because they had invested in meaningful private securities found out that those promises were meaningless.

Investing in private securities offers no promises. However, it does have a long history of a 6.5% real, annualized return. In fact, there has never been a 40-year period in which the S&P 500 had less than 4% real, annualized return.

SS recipients, on the other hand, are still receiving their scheduled benefits.

That's not entirely true, now is it?. Social Security recipients had their scheduled benefits cut. Just ask anyone born after 1937. My mother was 45 in 1983. She had been paying Social Security taxes for 27 years when her Social Security benefits were cut. It's easy to keep paying scheduled benefits when you can raise taxes and cut benefits with the stroke of a pen.

It's especially easy to keep paying scheduled benefits when you don't promise very much. According to the CBO, the median American will pay more in Social Security taxes than they'll ever receive in benefits. In comparison, investing monthly over 40-year at 4% will yield 2.5 times your principal. I know which one I would pick.

You are taking a far too narrow view of the "intergenerational compact" and how the boomers are breaking it. The deficit itself is an inter-generational wealth transfer: boomers consume today, their children pay for it later (I am assuming, of course, that public debt is not used to invest in the productivity of the economy). You are right, of course, that without the trust fund surplus the boomers would be making out even more like bandits. But it doens't mean that they are not already. The government will have to repay the deficit somehow, and the options are basically (a) higher taxes on workers (after the boomers retire), (b) cutting social security and other government spending (after the boomers are dead), (c) a miracle of economic growth that is highly unlikely, or (d) default.